How To Pay Tax As A Sole Proprietor

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I am a mama and CPA for ambitious female entrepreneurs.
I love the number, people and beautiful things. I can sit hours to listen to others dream, passion, concerns and help them achieve their financial goals.
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You are a freelancer, or you are a sole proprietor. Your business is doing well, but you find it quite challenging to pay tax and handle your business finance. It looks like you are buzzing the numbers. Even you talk to a tax specialist, you still feel it overwhelming. No worry at all. I will help you break the tax part down so you are confident about it. Now, please take a deep breath as we dive into the detail.

1. Reporting Income As A Sole Proprietor

    When you operate a business as a sole proprietor, you report your business income under your personal tax form. Your business is considered as a pass-through income. The form is form 1040, and your business income reports under schedule C. You are taxed based on your profit, not income from your business. This means that you get the total revenue minus all of the business expenses to arrive at the net profit.
A common misunderstanding that you earn less than $600 on some client works would not need to report the revenue. You are required to include all of the income regardless of the amount. In some cases, your clients do not issue form 1099s to you because the payment amounts were less than $600. Please note that IRS already update the form 1099 MISC to form 1099 NEC for your independent contract works. So, make sure you look for the NEC form instead of the MISC.

2. How To Calculating Quarterly Tax Payments

     You are required to make quarterly estimated tax payments if you expect to owe tax more than $1000 for a year when you file your tax return. Naturally, if you work as an employee for other companies, your employers would withhold your tax part from the salary and pay to IRS every month depending on your salary level. Yet, if you own a business, there is no withholding tax on your income. Therefore, you need to pay the estimated tax quarterly, depending on your income level.

     If you work as an employee, your employer will pay half of the social security (6.2%) and half of the Medicare (1.45%). Yet, if you run your own business, you will pay for both employee and employer parts. It is called a self-employment tax. If you make more than $400 in net income from your business, you need to pay this tax. I know that you feel this makes you pay higher tax. You can deduct the employer part before arriving at your adjusted gross income. This will show up on your form 1040 when you file your tax return at the year end.

     To pay your quarterly estimated tax, you need to file form 1040 ES. You can use the Form 1040 – ES link to calculate how much tax you need to pay every quarter. I know that the form’s formula is funky to follow, especially for the first year you are in business. If you are in business for a couple of years, you probably have previous years’ records. The safe harbor rule is that you need to pay at least 90% of your tax amount during the year to avoid the penalty.

     You can calculate the estimated tax based on the calculation below:

  • Step 1: Calculate your revenue from the business.
  • Step 2: Calculate your business expenses.
  • Step 3: Net Income = Revenue – Expenses
  • Step 4: Using this net income and add to other income you received during the year like w-2, your husband/wife income. You will arrive at the total income of your household.
  • Step 5: the total income – Deductible above the line items= Adjusted Income. The deductible above the line may be student loan interest, HSA contribution, 401k/ IRA contribution.
  • Step 6: Adjusted income – standard deduction- tax credits= taxable income.
  • Step 7: Multiply your taxable income with the percentage of the tax bracket schedule.

     To make tax more straightforward for you, I make these steps for you to feel comfortable to follow. Yet, each household individual has a different situation and circumstance, so please do not use this as an absolute solution. You can use this to estimate how much your tax. You can also use this to double-check your tax returns if you file yourself or hire someone does for you. One of the thumb rules for every net income you make from your business is saving 30% of the net income for tax.

3. How To Make Estimated Tax Payments

     Your estimated tax payments are due quarterly on the 15th of the month after each quarter. For example, first quarterly estimated tax is due on April 15. This is for the period from January – March 31. I link the list of payment dues date from IRS website  for your reference.
     As I mentioned before, making sure that you set aside funds every month will help you avoid the burden of huge payment on each dues date. I know some of my clients feel so overwhelmed when they need to pay the tax. I advise to set aside fund so they are ready.

     I also recommend that you book into your calendar a reminder so you remember to pay your estimated tax on time.

     To pay the estimated tax payments, you can pay by checks, credit/ debit cards or ACH. If you pay by checks, making sure to attach a copy of your quarterly 1040ES, so IRS has your information and book your payments.

     For other payment methods, you can find the link here .

     As mentioned, you can avoid penalties for underpayments if:

• You owe less than $1,000 in tax for the year.
• Or if you paid 90% of the tax for the current year or you paid 100% of the tax on the prior year, whichever is smaller.

4. How To Reduce Your Taxable Income

     There are a list of deductible business expenses. The deductible expenses also change based on the business structure or entity structure you report for your business. I will write about the business structure in another post. Making sure you know the list of deductible business expenses.

     As your own employer, you can setup a 401k. There are couple of options for your own 401k. Making sure to check with your financial advisor so you can have a detailed plan for yourself.

     You also can setup a HSA account for yourself so you can set aside fund for your future medical expenses. HSA account has so many benefits that I will write about it in another post.

5. Conclusion

      In conclusion, I know that tax is not for everyone. All of the rules and requirements can be overwhelming to many. I hope this post help you with necessary information in one place and you can reference back when you get ready to pay tax. And of course, because tax is never simple, making sure you talk to an accountant and tax preparer to help you nail down your tax situation. Please let me know how do you plan to pay your tax? And if you have any questions.

Mama, number nerds, espresso obsessed, SOURDOUGH ENTHUSIASTS

Hi, I'm Fiona.
Your CFO and profit strategist.

I am a CPA for female entrepreneurs. I am on a mission to help Ambitious female entrepreneurs take control their number, level up their Business finance and become wildly financial success.

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